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Is Diageo's $115M Move in Whiskey Smart, or Will It Prove a Blunder?

Diageo, the world's largest spirits maker, has big plans for American whiskey in the U.S. And why not, with bourbon and Tennessee whiskey at peak popularity. Will this $115M investment prove money well spent, or will drinkers' tastes shift, making it a blunder?

Diageo(NYSE:DEO) last week announced plans to build a $115 million distillery in Kentucky over the next three years. This is an investment triple the size of Brown-Forman's (NYSE:BF-A)(NYSE:BF-B) $35 million expansion of its Woodford Reserve distillery. The Diageo distillery will also be capable of producing three times the amount of whiskey as Woodford does in total right now.

Clearly, Diageo is making this move with big demand in mind. It says the distillery will produce its growing Bulleit whiskey label, as well as “future Diageo bourbon and North American Whiskey brands.”

Diageo's popular Bulleit bourbon. Source: Wikimedia Commons

That seems reasonable, since it comes at a time when American whiskey has never been more popular. Sales grew by 10% in the U.S. in 2013 and 7% worldwide. For comparison's sake, the U.S. beer market was stagnant.

Even more important to this story, sales of high-priced whiskeys have fast been on the rise, nearly doubling in the six years leading up to 2013. So, it's a good bet that those “future brands” are going to be high-end bourbons. Diageo has plenty of experience in high-end whiskeys as the producer of Johnnie Walker scotches.

But this investment is much riskier than it may first appear. The problem is that while whiskey – and particularly bourbon – is all the rage right now, spirits drinkers' tastes have historically been fickle.

A lotta time in the barrelThis distillery should be up and running in just three years, if the company holds to its plan. But a bottle of bourbon or whiskey takes years to produce. It's that time spent sitting inside charred oak barrels that gives a good bourbon all its distinctive, mellow flavors. Jim Beam white label is aged four years, on the short side for bourbon. The better bourbons spend eight or 10 or even 12 years in those barrels, mellowing and taking on richer flavors before they are bottled.

That's why many labels are running low on supplies. Producer Buffalo Trace, for example, continues to run into shortages over the past several months. There's no way the distillers could have foreseen today's exploding interest in bourbon and Kentucky whiskey. Now that it's here, all they can do is increase production and hope that the demand is still there 4, 6, 10, or 12 years from now.

Demand in high-end, "craft"Brown Forman's Woodford Reserve grew sales 28% globally in fiscal 2013. Beam, recently acquired by Japanese spirits maker Suntory, saw its top-shelf bourbons like Maker's Mark, Knob Creek, and Basil Hayden's growing quickly. Basil Hayden's, the most expensive but least popular of the four, grew at the fastest rate over the company's last nine months reported before the sale, notching 34% growth. It's clear that there's a big appetite for high-end and craft-style whiskeys in the U.S.

Bulleit – and its embossed glass bottle that looks more like an oversized flask than a typical squared-edged whiskey bottle – sits on shelves along with craft whiskeys from smaller makers. Since it doesn't have the name recognition of brands like Jim Beam, Jack Daniels, or Old Grand-Dad, it's easily mistaken for a “frontier whiskey” and not something from the world's biggest distiller. With the trend in beer, coffee, and now spirits moving toward "craft" brands, that's a good thing.

The Foolish bottom lineLondon-based Diageo's decision to build a $115 million distillery in Kentucky is great for the local economy, no doubt. But whether its a smart move will depend on the appetite for the fickle spirits-drinking public. If demand for American whiskey – particularly at the high end – holds up, this investment could pay off in spades. But if drinkers' tastes shift while Diageo's 750,000 nine-liter cases of bourbon are still years from hitting tumblers and ice, it could prove to be a $115 million mistake.

Author

Fool contributor John-Erik Koslosky has been picking his own stocks since the market crashed in 2008. He aims for a mix of value and growth, but mostly, just looks to buy great businesses.
Follow @JE_Koslosky